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Payments Trends and the Innovator's Dilemma

20 January 2016

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The latest World Payments Report by Capgemini pointed to some key trends for 2016. The payments front end is rapidly changing with
new non-bank entrants providing newer ways of bringing customers and merchants together. Other than many Peer 2 Peer platforms that surfaced a few years ago, we've also seen the entry of Apple, Samsung and Google into the fray.

What's interesting to me is to see the Innovator's Dilemma in full effect, a theory put forth formally by Clayton Christensen in
his book by the same name.

According to me, the biggest priority for banks today should be to maintain the customer front end. They've traditionally occupied a safe and comfortable position in the business ecosystem as the primary brokers of money. But that's changing rapidly. Even
today, most of us we don't even think about our bank or credit card issuer when we transact. They are in the background enabling the service. What we instead interact with is our phone or the retailers website or App. Even when we pay with a credit card, the
motivations and interactions are with the retailer, or our mobile phone. The card is just something that has to be swiped. That by itself was not a risk until recently especially because the banks motivated us with reward points and airline miles.

Then the Target REDcard came along. Based on existing technology, its a proprietary payments network that manages to bypass most of the inherent fees by middlemen in the payments ecosystem, and offers us a straight 5% off our purchase. And now we have Apple,
Samsung and Google threatening to steal the customer front end. Add to the mix innovations like WalMart Pay, WalMart shopping App, and the WalMart gift card put together, and who needs a bank? The unbanked have a new way to manage their money.

As most banks already agree, there is nothing really preventing technology firms from becoming banks. Just like there was nothing to prevent Amazon from evolving to sell everything, even Television shows, and groceries.

The innovators dilemma stems from the inertia that is gripping the system today. The attention is on the revenue streams of today, and how they can be influenced by new innovations such as the online shopping malls that banks successfully created. The attention
should now be on the new revenue models of tomorrow which are gradually replacing the revenue streams of today.

As we have seen with disruptors such as Uber, and Airbnb, the models for tomorrow may well arise from being intermediaries of value. Banks actually have something far more tangible in the form of customer trust and relationships, not to mention the world's
entire commerce infrastructure. We've already seen BBVA partnering with Dwolla, and acquiring Simple. Some other leading banks are doing the same. They key is to establish partnerships with agile innovators even as aggressive technology and business process
transformations are undertaken internally. The immediate priority is to maintain the ability to influence the business models of the future by staying in front of the customer, and not in the background enabling transactions.

Comments: (7)

"Who needs a bank?" I can't believe I'm reading this. Pray tell me how will Apple Pay work without the issuer bank that issues the Apple Pay-enrolled card and the acquirer bank that allows the merchant to accept the Apple Pay payment? Do you have any figures
on how many unbanked people have iPhone6 required to use Apple Pay? Sorry but the reality is quite opposite:
Apple Puts Banks Squarely At The Center Of Mobile Payments

Would you've cited UBER as a disruptor in an article whose title includes the expression "innovators dilemma" had you known that the founder of this expression, Clayton Christensen, had recently declared
that UBER is NOT a disruptor?

The point I was making is that inertia often appears in the form of resistance or justification, until there's no choice but to reinvent or succumb. E.g. Apple Pay uses cards, or Uber is not really a disruptor etc. The fact is that when the customer front
end of our core business moves to others, there is a very real risk of disintermediation, and loss of relevance.

I know Mr. Christensen declared that Uber is not really a disruptor by alluding to some parameters of disruption he has defined. But the fact is that models like Uber has disrupted the market, just as Airbnb has done in the hospitality sector. Models like
Uber are not easily threatened by other taxi cab companies coming up with mobile channels of their own, because the individual scale is miniscule. The model is very different - its not just a mobile app (or maybe its just a mobile app without any capital investments!)
And any subsequent loyalty programs will attract much better affinity from customers exactly because of that. A better response by incumbents would have been to create a similar channel to combat the trend, which Flywheel has started to do now. But it's tough
if not done early. We questioned customer service, safety, availability etc, until this model became too strong to be denied recognition anymore.

As for banks, obviously they will exist. The issue is with giving up the customer front end which makes it harder to innovate on new revenue models which fit the future. Instead we are left protecting our traditional business in the form it remains. In essence,
mobile payments are like Uber. The more someone else controls the front end, the more information about the customer they have. At this time, mobile payments are just another channel for banks and cards, but given how fast the market is changing, preparations
must be actively made to counter a change in the channel partner's business models. We're seeing similar trends with Robo Advisors in wealth management, as well as with lending. They are both competition as well as partners.

Hope this clarifies. There's always 2 sides to the coin, and I appreciate your perspective. Thanks again for taking the time to read my blog.

What you call "giving up the frontend" is what I call "increasing reach, reducing cost, and increasing profits by moving operational costs and risk to third parties".

Disintermediation happens when producer and distributor are two different entities and a new form of distribution can disintermediate the incumbent distributor (though not the producer). To take a simple example of DOVE soap:

Producer: P&G

Incumbent Distributor: WalMart

New Distributor: Amazon

If enough consumers prefer to buy DOVE online via Amazon, if WalMart does not respond to this, then Amazon will "Amazon" WalMart, but P&G's status doesn't change. For all we know, Amazon could actually increase P&G's revenues by finding new consumers for
DOVE from places where there are no WalMart stores or DOVE was otherwise not available in brick-and-mortar stores.

In the case of payments, which is the subject of your blog post, let's see the value chain:

Producer: Card issuing bank, Card acquiring bank

Incumbent & New Distributor: Card issuing bank, Card acquiring bank

New "Distributor": Apple Pay

Regardless of how many cardholders move to Apple Pay, banks continue to remain the producer and distributor. The frontend relationship has not moved to Apple Pay - it has extended to Apple Pay. Bank knew the cardholder before, bank continues to know the
cardholder now. If bank wants to do targeted marketing to increase ticket size, boost loyalty and whatever, it can do so, Apple Pay's entry has not undermined that capability in any way. There is absolutely no question of bank getting disintermediated in Payments
from any new alternative payment service provider as things stand.

In the context of Payments, the relationship between Bank and Third Parties is akin to that between a Principal (say SAP) and its Resellers in my native IT industry. Principal can resell its own product to the end customer but it still chooses to develop
a network of Resellers. In the process, the frontend relationship shifts to the Reseller; the Principal also gives away a certain share of its revenues to Resellers by way of commission. Why does a Principal still create a Reseller network? Is it because it's
stupid and exhibits inertia and suicidal tendencies? NO. It's to increase reach, reduce cost of selling and, in the case of Bank-SQUARE, to shift its risk to Reseller (as highlighted in my blog post http://qwt.io/s_ketharaman/7lXM). There's no question of
disintermediation of banks by Resellers, just as there's no question of disintermediation of SAP by Resellers.

Like I said, its all about protecting the future, not framing our discussion in the present.

Amazon and Walmart have the power to recommend Unilever over P&G. That's why P&G is trying to go direct to consumer, and also spends on advertising. It's about who can create a sticky customer community. Branding has the power to influence, but its no longer
the only thing.

Its a similar case with payments. First, you are assuming the back end is going to remain traditional banks. Second, you are focusing on the current revenue stream, not those of the future that come from being close to the customers and their non-banking
transactions. Third, customers generally have more than one bank set up on their mobile so the battle is always on.

Your question was "Who needs a bank?". That sounded like present. Had you asked, "Who will need a bank?", I'd have commented differently:

You're assuming that banks are not advertising directly to consumers. A majority of Top 10 costliest keywords on Google AdWords are related to financial services, which suggests otherwise.

You're assuming that the current frothy environment for VC funding for neobanks / fintech will continue forever. Recent IPO of SQUARE, almost 50% drop in stock price of LC and OnDeck since IPO - they all suggest otherwise.

You're assuming that nonbanks will create viable payment backends. I've been hearing this for almost 10 years but payment backends have stayed with banks for the past 50 years. MNOs tried creating alternative rails with Carrier Billing around 5-6 years
ago but that didn't go far (Banks Have Nothing To Fear From TELCOs). I'll believe your assumption if and when I see it happening in the real world.

I've seen more predictions about disruption in financial services turning out false than true (see my comments at http://www.finextra.com/news/fullstory.aspx?newsitemid=28259). So, I'd rather stay with the present. Besides, from what I'm observing, I've
more reason to believe that neobanks are fearing disruption by traditional banks. To predict the opposite in future is idle speculation that I'll not indulge in.

All the partnership and acquisition activity in the FinTech space does suggest that banks are taking the right steps (mostly). So I hope our banks will not only be around (that won't be enough) but will maintain the customer front end. Amen to that.

Once upon a time, I'd call a plumber 3 times for fixing an appointment for one visit, get used to his arriving 3 hours late and that too after several reminders, haggle over quality and price, and otherwise go through a torrid experience. Nowadays, I book
a plumber on the slick frontend of one of the 50+ "Uber for Handymen" apps, select an appointment when it suits me, tweet to the app startup if I've a problem, pay by predefined rate card, generally get 10-25% off on the rate card because the app startup has
enough VC funding to blow on customer acquisition. Ditto with cabs, grocery stores, restaurants, and so on.

As long as I'm assured that my money is safe in the backend of an insured bank account, I'd love to switch to the frontend of a neobank - many of them support 1-tap payment, improve CX and, instead of charging me a premium, actually give me a 10-15% cashback
because they have VC backing for burning cash.

It could be argued that such VC-funded largesse from neobanks is not sustainable. I'd totally agree. But how does that matter to me or to the banks? At worst, I'll have to switch to another neobank if some of them shut down, forfeit cashback if all neobanks
stop giving it, forfeit the nonbank frontend if all neobanks shut down. When all is done and dusted, I can always go back to my good old bank's bad old frontend. Neither the bank nor I have lost anything in the bargain.